Excessive Debt May Sink Global Stocks to Crisis Lows, Says First State

By Shani Raja and Lisa Pham -
Jul 6, 2010

The stimulus-driven global economic
recovery is threatened by excessive corporate and government
debt that may push global stocks to below their post-credit-
crisis lows, said Alistair Thompson of First State Investments.

That suggests a drop of more than 34 percent for the MSCI
World Index from yesterday’s 1,051.60 closing level. This could
occur within the next 18 months, according to Thompson, who co-
manages First State’s Asia Pacific (ex-Japan)/Global Emerging
Markets fund. First State managed about $126 billion as of
December 31, according to its website. The fund is skewed toward
“defensive” stocks, he said.

“We’re anticipating much slower economic growth in the
coming period,” said Thompson, who is based in Singapore.
“There’s a distinct possibility global markets could return to,
or fall below, their bear-market lows. The big problem at the
moment is government leverage, bank leverage, and in some places,
consumer leverage.”

The MSCI World Index tumbled 59 percent from its record
high of 1,682.35 on Oct. 31, 2007, to a 14-year low of 688.64 on
March 9, 2009, after Lehman Brothers Holdings Inc. collapsed,
triggering a financial crisis that precipitated a global
recession. The gauge rallied 70 percent through the rest of 2009
as governments spent more than $2 trillion in fiscal stimulus to
spur economic growth, aiding a worldwide recovery.

“The initial remedy was piling on loads more debt,” said
Thompson. “But it’s odd to think you can solve a debt crisis
with more debt. At some point, you have to wean yourself off.”

Aggressive Tightening

Already industrial countries are embarking on the most
aggressive tightening of fiscal policy in more than four decades.

Rich nations will reduce their primary budget deficits,
excluding interest payments, by 1.6 percentage points next year,
the most since the Organization for Economic Cooperation and
Development began keeping records in 1970, according to JPMorgan
Chase & Co. economists. The budget squeeze will cut 0.9
percentage point from growth in 2011.

The problem of excessive leverage is less in Asia than in
more developed markets, according to Thompson.

“Asia is economically in much better shape,” he said.
“The problem is that the region is still heavily dependent on
developed markets for exports, so we’re not immune.”

The MSCI World Index has lost 10 percent this year through
yesterday as European sovereign debt crises, China’s steps to
curb asset bubbles, and worsening U.S. growth indicators
threaten to choke off the recovery.

China Growth

Goldman Sachs last week cut its full-year 2010 forecast for
expansion in China’s real gross domestic product, while the
latest reports on U.S. manufacturing, employment and home sales
pointed to slower growth in the second half of the year.

This year, concern has also grown that European countries
in addition to Greece will struggle to curb their budget
deficits or repay debt. The MSCI Asia Pacific Index fell today
for the fifth time in seven days after slower-than-estimated
expansion by U.S. service industries added to speculation global
growth is faltering.

First State’s Thompson says his fund is waiting for markets
to fall further before modifying the “defensive” posture it
has held for the past three years.

The fund is geared toward less risky investments, said
Thompson, with about 12 percent allocated to gold companies,
more than 10 percent to telecommunications stocks, and roughly
14 percent to consumer-staples-related firms.

“Since the beginning of 2007, we’ve had very little
exposure to banks or commodity companies, with the exception of
gold,” he said. “Our portfolios are probably as defensively
positioned now as they’ve ever been. But we’re always looking to
pick up some real quality at bargain prices.”